Social Lending Arbitrage

Its been six months since I first introduced my Social Lending Arbitrage method to the mydollarplan community, and Madison has asked me to provide an update on where I stand with my method.

To summarize the idea, this method basically plays an arbitrage game similar to the no-interest credit card arbitrage popular on the site but with a slightly different twist in that I’m borrowing money at a lower interest rate and lending it out at a higher interest rate — and pocketing the difference.

Social Lending Arbitrage Numbers

I borrowed $10k from lenders at the Lending Club website at an interest rate of 7.78% and turned around and invested that capital (minus some service fees taken out by Lending Club as a part of the loan) to other borrowers with a higher risk profile than myself. It is a method wherein I profit off of varying appetites of risk. I have a higher risk appetite with this money than other lenders and as such, I make a return off borrowed money (Note that I have enough cash held in reserve from other sources that I am able to cover my loan should the social arbitrage world end tomorrow, so my sense of risk is appropriately higher than someone who does not have that).

Metrics as follows:

• Amount Borrowed: $10,000
• Interest Rate: 7.78% (Or $1,245 over 3 years)
• Total Fees: 1.25% (note that this has since gone up to 2.25%) (Or $125)
• Total Cost of Capital (3 yrs): $1,370 (13.70%)

Loans:

• Amount Loaned: $9,875 ($10,000 minus $125)
• Loans filled ($25 per loan): 395
• Est. Default Rate: 2.5% ($247 in total)
• Net Invested: $9,628
• Average Annualized Return: 14.69%
• Service Charge: 1%
• Net Return: 13.69%

Total Return of Invested Capital (3 yrs): $2,166 (22.5%)

Arbitrage Gain (3 yrs): $797

Social Lending Details

I personally choose all 395 loans, which I feel was incredibly time-consuming, but also ended up being to my benefit, as the default rate is lower than normal (outlined in more detail below). I have not decided whether I would go that route should I do this again in the future, since it was more time-consuming than I was ok with.

The beauty of this system is that I have isolated all transactions related to this set up to one bank account which is fully automated — I don’t touch it month over month. My only real work after initial set up was to determine whether my default rate is staying below my forecasted rate of 2.5% (which I update quarterly).

I am 1 year into this plan and thus far, of the 395 loans I have funded, I have had 2 default (one with 3 payments made in total, the other with 6), which translates into a 1.50% default rate (assuming I will have another 2 default per year through the remaining 2 years). This equates into more of a return than I had originally forecasted. Happy day!

While it is next to impossible to determine which loans could potentially default in the future, I was highly surprised that of the sheer number of loans I have funded, 10 have had any late payments, and of those, only 2 have defaulted. My thought behind this is that barring unforeseen financial hardships that could occur to my borrowers, I would expect those that have been paying so far to continue to do so through the end of the loan term.

Selling Riskier Loans

I have kept a close eye on the credit scores on all my loans with a lower than B rating (the riskier loans in my portfolio) to see if they are getting “riskier” than they were when I originally funded the loan. Should any fall substantially far below their original rating (something at this point I consider subjective from both a rating perspective as well as my own viewpoint), I plan on selling the debt to someone with a higher risk appetite than myself.

How to do so? Luckily for me (and others), Lending Club and Prosper have provided their members the ability to sell the debt they own to other members on a trading website Folio Investing. This adds a degree of flexibility to lenders in case they want to pull out on one or many loans. It effectively provides me the ability to increase my liquidity should I need it (although there is the potential I would lose my return or even my principal should I have to firesale the debt). In my mind, the more options I have for worst-case scenarios, the better I can exit this position and minimize my losses should the worst happen.

Social Lending Projections

Using the updated default rate, my new forecast calls for me to earn approximately $835 over 3 years. This assumes I do not reinvest the return I make on new loans (which at this point I am not doing), so theoretically this return could be higher than that should I choose to do that (which I am considering, but have not had the time to properly research new loans). The idea that by reinvesting, I compound my return makes this plan all the more enticing! Not only am I receiving free money, I begin to see an even greater return as the free-money snowball gets larger over time.

I must reiterate that this investing method is definitely not for everyone. Every investment has a level of risk and while I feel this is easy enough for myself to earn a small return, others may not like the inherent risks of investing in a new vehicle such as social lending is. This is a relatively new type of investment and while the intent behind the system is very noble, some may consider the relative ease of borrowers’ ability to game the system to be riskier than worthwhile. Others may consider the return in actual dollars to be too small for some people to consider – this may be more work than worthwhile. Again, its a personal decision.

For myself, free money is free money, and is completely passive income, which in my mind makes the process worthwhile. What kind of free money returns do you have?

Lending Club is giving a sign up bonus to try out social lending for free. If you haven’t taken advantage of it yet, you can try it out at: Lending Club $25 Sign Up Bonus.

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Good thing I didn’t toss the papers! The mutual funds were involved in market-timing and late trading in what was called the 2003 mutual fund scandal. I remember the scandal vaguely in the news, but at the time I didn’t realize we were affected by it since we were busy with our wedding at the time.

Mutual Fund Settlement

The court papers I received directed me to the mutual fund settlement website where it lists all of the mutual funds involved.

They mutual funds involved are:

• Alger
• AllianceBernstein
• Allianz
• Bank of America/Nations
• Columbia
• Federated
• Invesco
• Janus
• MFS
• One Group/Bank One
• Pilgrim Baxter (PBHG)
• Putnam
• RS
• Schwab/Excelsior
• Deutschebank/Scudder
• Strong

How to Get Your Mutual Fund Settlement Money

Here’s what you need to know about submitting a claim:

Mutual Fund Settlement Period: The time periods are different for each fund, but go as far back as October 1, 1998 through September 30, 2003.

Deadline to submit your claim: December 8, 2010.

Mutual Fund Settlement Process: If you got a notice in the mail, you can go to the website listed and file your claim form with the claimant number. If you didn’t get a form in the mail, you can still submit a claim directly on the website.

You will need to identify how many shares you held of each mutual fund at the end of each of the years involved. This is where I’m relieved that I have more than a decade of transactions in Microsoft Money. I can put together a report very quickly before I begin the tedious process of digging out all the statements.

Our Mutual Fund Settlements

Late last year we received a check from a Invesco mutual fund settlement, but I didn’t think much of it. Now that I’m looking into it, I realize we have a lot of affected mutual funds. Many of them are because our home state 529 plan was run by Strong.

But some of the mutual fund settlement times go back to when I was still in college. I was just learning about index fund investing, so I had money in many actively traded mutual funds included a handful on the list!

I guess I know what I will be working on for the next few weeks…

Time to check your investment histories! Are you involved in any of the mutual fund settlements?

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When Paul and I moved into our new home, my mother flew down from Pennsylvania and spent a long weekend with us. As a present, she gave me several bonds she had saved from when I was younger. I went into the first bank I found, even though I had no accounts with them, and redeemed my bonds. In total, they had accrued $329.52 in interest! It was a wonderful (and much needed) surprise. 

Now that you’ve been patient and have reached full maturity on your I Bond, or perhaps you simply need to get out of your I Bond because you cannot afford to have your money being used by the US Government any longer, let’s talk about how to redeem them.

Penalties for Redeeming I Bonds Early

While I Bonds mature after 30 years, you only need to hold onto them for one year before you can redeem them for the face value and any interest accrued. However, if you redeem your I Bond between one year and five years from purchase, then you will be penalized. The penalty is a forfeiture of the last 3 months of interest payments (remember that interest is accrued monthly, and compounded semiannually). You will incur no penalties for redeeming your I Bonds after five years of purchase.

Where to Redeem I Bonds

Paper I Bonds can be redeemed at most financial institutions, while electronic I Bonds can be redeemed electronically through TreasuryDirect. First you will have to decide whether to redeem the entire bond, or part of it. Partial redemptions of paper or electronic bonds are allowed in $25 increments; you will be issued a new bond in the remaining balance of the old one (there must be at least $25 remaining value).

How to Redeem Savings Bonds

To redeem your paper I Bonds, go to a bank that has a savings bond program (call ahead to verify). Some banks will only allow you to redeem Series I bonds if you are a customer, so check in advance for this requirement.

You will need the following to cash in US savings bonds: the paper bond (you can send off for a new bond in the event that you have lost your old ones using Form 1048), your social security number, and some identification with your signature, such as your driver’s license or passport. You will need to sign over the bonds to the bank by signing the back, and the bank will verify that you are, in fact, the bond’s owner. If you cannot find a local bank to help you, or you are redeeming a large amount of bonds, then contact your local Treasury Retail Securities for help.

To redeem savings bonds online, log into TreasuryDirect and click on the Savings Bonds link. Select the Series I Savings Bond Option, and click on the bond you wish to redeem. Click on the “redeem” button in the next screen (please note: if the bond is less than one year old, there will not be a redeem button).  If you have multiple accounts connected to your TreasuryDirect account, then you can choose which account you wish the deposit to go to. 

Tax Expectations and Savings

The interest you earn on I Bonds is taxable by the federal government, but not by the state or local government. Therefore, expect to receive a 1099-INT form around tax time the following year after you cash in savings bonds.

You must declare the interest earned as income on your tax return. However, if you have educational expenses from the same year in which you redeemed your I Bond(s), you may not have to pay the federal taxes. Check out information on the how to cash savings bonds to pay for college in order to determine if you qualify for tax savings.

You can check out the previous articles in the series: Comparing Different Types of Treasury Securities and Everything You Need to Know About Buying I Bonds.

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I Bonds were once only available in paper form, but now the Government offers a buying and redemption process that takes place almost entirely online. In fact, the Government plans on making the purchasing of bonds only available electronically in the future. Below, I will discuss the ins and outs of purchasing these bonds.

I Bonds Current Rates

The current rate for I Bonds is 1.74%, and this will not be changed again until November 1, 2010. The fixed rate is 1.54%, and the variable rate is 0.20%.

Series I Bond Purchase Limits

A minimum of $25 is needed to purchase I-Bonds electronically, and a minimum of $50 is needed to purchase paper bonds. Each year, you are allowed to purchase up to $5,000 in Series I Bonds/Series EE Bonds electronically, as well as $5,000 paper issued bonds. That means you can purchase up to $10,000 in bonds annually.

Who Can Purchase I Bonds

The following are requirements for being able to purchase bonds: you must have a social security number, be a citizen of the United States, civilian employee working anywhere, or be a citizen living abroad. Minors can also purchase I Bonds.

Where to Buy I Bonds

You can purchase paper I Bonds in most financial institutions, including banks and credit unions. You can also buy Series I savings bonds online, a process that will streamline your purchasing experience for free. There are also many perks to purchasing bonds online, such as the ability to purchase your bonds 24/7, scheduling recurring investments for up to five years, have your details (such as purchase date and maturity date) automatically tracked for you, and online redemption.

The first step to purchasing bonds online is to open a TreasuryDirect account. You will need to have your social security number, the bank routing number and account number, driver’s license, and an email address. Once you fill out the application, an access card will be mailed to you to ensure you are the true holder of the account. You will need this card to access your account. Once in, you can purchase bonds online, and they will credit to your account within one business day.

Automatic Investments

The Treasury is eliminating the paper payroll savings bond program where employees used to be able to automatically purchase paper I Bonds through their employees in order to save the cost of running the Savings Bond program. As of September 30, 2010, federal employees will no longer have this option, and this option will be eliminated for all non-federal employees on January 1, 2010. However, automatically purchasing electronic I Bonds is available by having an account with TreasuryDirect.

Once you open your account and receive your access card, go to the ManageDirect – View My Funding Options tab for instructions on submitting a request to your employer for a payroll deduction. Just like a normal payroll deduction, the deducted money from your paycheck will be sent to your TreasuryDirect account, and will go into a Certificate of Indebtedness (C of I). The C of I is simply a non-interest bearing security to hold your money before you purchase your bonds. Once you accumulate enough money ($25 is the lowest denomination to purchase a bond electronically; $50 is needed for paper bonds), then you can purchase them through your account. Don’t forget, you can set up recurring purchases so that this process is done automatically.  

You can also purchase I Bonds directly with money you receive as a tax return. Check out this article for more information on how to purchase I Bonds using your tax return.

How to Exchange Paper Bonds for Electronic

If you would like to open a TreasuryDirect account to purchase future bonds with, but still have some paper bonds, you can convert the paper bonds into electronic bonds using SmartExchange.

What to Do if Your Paper I-Bonds are Lost/Stolen/Destroyed

If your paper I Bonds are lost, stolen, or otherwise destroyed, you can get replacement ones by filling out Form 1048 and submitting it to the following address:

Bureau of the Public Debt
PO Box 7012 Parkesburg
West Virginia, 26106-7012

Next in the series on I bonds, we’ll discuss online redemption.

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With the stock market swinging up and down like the pendulum of a grandfather clock, treasury securities (bonds) have become quite the hot topic. One may not become rich from purchasing them (though it depends on how much is purchased, and how long until maturity), but bonds have many great characteristics that make them a part of any sound investment portfolio.

Just a few of these characteristics include the guarantee of the US Government that you will not lose your principal money, exemption from state and local income taxes (federal taxes must be paid unless you cash in the savings bonds to pay for college), low incremental investing to get started, and being able to confidently purchase them directly, thus cutting out the middle man and saving on fees.

Series EE

• Maturity Date: 30 years
• Minimum Holding Period: You must keep this bond for at least 1 year
• How are you Paid: Both interest and principal are paid in one lump sum when you redeem
• How is Interest Accrued: Interest accrues monthly, and is compounded semi-annually
• Interest Rate: Fixed from the day you purchase it

Series I Bond

• Maturity Date: 30 years
• Minimum Holding Period: You must keep this bond for at least 1 year
• How You are Paid: Both interest and principal are paid in one lump sum when you redeem
• How Interest is Accrued: Interest accrues monthly, and is compounded semi-annually
• Interest Rate: Fixed rate from the day that you purchase until maturity, plus an inflation rate premium that changes every six months in May and November (your yield will be these two rates added together)

T-Bond

• Maturity Date: 30 years
• Minimum Holding Period: None
• How You are Paid: Every six months you receive interest money; when you redeem you will be paid the face value
• How interest is Accrued: Every six months interest earned will be paid to you
• Interest Rate: Fixed rate from the day that you purchase until maturity

TIPS

• Maturity Date: 5 year, 10 year, or 30 years
• Minimum Holding Period: None
• How You are Paid: Every six months you receive interest money applied to the adjusted principal; when you redeem you will be paid the adjusted face value or original face value, whichever is greater (principal changes in accordance with monthly changes to the Consumer Price Index to account for inflation and deflation)
• How Interest is Accrued: Every six months interest earned will be paid to you
• Interest Rate: Fixed rate from the day that you purchase until maturity

As you can see, each of these bonds offers their own assets to your portfolio. For more information on any of these, and also on Treasury Bills and Treasury Notes, please see TreasuryDirect.

In the next article of this series, I will discuss the Series I Bond in more detail, as well as take you through the process of how to purchase them.

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Since the 2010 tax deadline (which is also the last day to contribute to an IRA for 2009) is just days away, you’ll have to act quickly if you want to start a new IRA and maximize your contribution.

Can You Have a 401k and an IRA at the Same Time?

Yes, you can invest in both an IRA and a 401k (or a Roth 401k and a Roth IRA) at the same time, or any combination of those accounts.

And in some cases, based on the fees in your 401k, an IRA might actually be a better place to invest your money.

Limits on 401k and IRA Contributions

If you want to contribute to both a 401k and an IRA in the same year, the contribution limits are based on your income.

Traditional IRA contributions do not have income limits, but the income limits for a Roth IRA phases out for single filers between $105,000 to $120,000 ($166,000 and $176,000 for married) for 2009.

See the 2010 Roth 401k and Roth IRA Limits for all the contribution limits for 401ks and IRAs.

Which Order to Fund the Accounts

Ideally, you’d want to maximize contributions to both your 401k and your IRA. However, if you aren’t saving the full amount, you’ll have to determine which account is better for your money.

Here’s the strategy that I’ve always used when funding retirement accounts.

1. Contribute the minimum to the 401k to get the full match.
2. Contribute to a Roth IRA until you hit the income limits.
3. Contribute any additional IRA contributions to a traditional IRA, with plans to make a Roth IRA conversion.
4. Max out the rest of the 401k.
5. Finally, save the rest in a taxable account.

Don’t forget to report your contributions on your taxes, and take the Saver’s Credit for Retirement Contributions if you are eligible!

Deadline to Open an IRA

If you haven’t started an IRA, you have three more days to start one! I helped a client open a small IRA this morning at Scottrade which took less than 10 minutes.

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When we made changes to our most recent asset allocation to include more international exposure I identified the need to pick up more emerging markets, in an ETF instead of index funds.

I hold a lot of our index funds at the big names… Vanguard, Fidelity, and Charles Schwab, but I’m looking specifically for discount brokers here for the ETF to pick it up on the cheap.

I’m evaluating all the discount brokers based on cheap trades, account fees, ability to easily transfer in and out of, and how IRA friendly they are. Of course, low minimum account balances are nice too, since I like to move my money around. Based on those requirements, I came up with the list below.

The other important piece in finding the best discount brokers is getting your input. I have accounts at half of these, but not the others. However, with the OptionsXpress $100 Sign Up Bonus, I’ll probably open an account there soon.

So tell me, which is your favorite discount broker? Feel free to leave comments why you like or dislike each.

Note: There is a poll embedded within this post, please visit the site to participate in this post's poll.
Email readers can vote here: Which is Your Favorite Discount Broker?

Stay tuned and I’ll put together the results on the best discount brokers soon!

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How to Get Your Sign Up Bonus

1. Open and fund an OptionsXpress account with $500 by December 31, 2011.
2. Execute three trades within 12 months of opening the account.
3. $100 will be deposited into your new account within a month of meeting the conditions above.

OptionsXpress Terms and Conditions

• OptionsXpress may charge the account for the cost of the $100 bonus should account fail to remain open with minimum funding (excluding trading losses) 6 months from the account open date.
• IRAs, other tax-exempt, linked, or shared accounts are not eligible to receive the $100 bonus offer.
• The offer isn’t transferable and isn’t valid for internal transfers, current optionsXpress accounts or with any other optionsXpress offers.
• There is a limit of one offer per person and the offer is limited to U.S. residents..

More on optionsXpress

Low Fees. OptionsXpress offers low low fees on trading options, stocks and futures.
Investment Tools. OptionsXpress offers trading tools like their product for advanced traders, Xtend.

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International Asset Allocation Changes

When we started using a total market approach for our portfolio I began with a 20% international (18% of the total portfolio) allocation, with plans to increase it each year.

As of our last asset allocation, I had 30% (or 27% of the total portfolio) international allocation.

Now I’ve moved it up to 35% (31% of the total portfolio). This may or may not be the final move; next year I may move it to 40%.

Here’s how our portfolio currently looks.

International Holdings

Our international holdings currently include Vanguard Total International Index, the BGI EAFE Index Fund, and the Vanguard Emerging Markets Index.

In addition to the overall asset allocation, I also like to keep the EAFE at 85% and emerging markets at 15% of the total international holding.

Action Plan

Rebalancing our portfolio is always fun. Since our portfolio is split over 10 different retirement accounts (which I cannot combine), in addition to the asset allocation, I try to keep it (relatively) simplified and with the lowest expense ratio possible.

I came up with a plan to shift some of the bond holdings into the EAFE fund in Scott’s 457 plan. That should account for the majority of the change.

There’s still a slight need for some additional emerging markets. I hate to buy more of the Vanguard emerging market fund, since the expense ratio is .40% with purchase and redemption fees.

I recently compared the emerging market ETF shares to the index fund, and the ETF came out on top, so I’m planning to head that route.

However, since it’s a small holding in a small account, I don’t want to pay much for the trades, so I’m going to take a look at some of my other brokerage accounts to make the move.

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Social Lending Arbitrage Explained

Let me tell you about my arbitrage strategy that I’ve used successfully for almost a year on both Prosper and Lending Club.

In this instance, I borrowed $10,000 using Lending Club at a relatively cheap rate of 7.78%. I say relatively cheap in that A) it was being offered to me, and B) the price tag in the form of interest was small given the fact that it was actually being offered. This is by no means free money, so your returns will be lower than if it were a no interest credit card offer, however I’ve noticed those credit card offers have disappeared with the credit crunch we’ve been seeing over the last two years, and bank lending has similarly been affected as well.

That being said, my risk appetite is somewhat greater than the average person’s, and my investments tend to reflect that. I took the $10,000 I borrowed from Lending Club, and put it right back into Lending Club (with a balance also going to Prosper as well), looking for somewhat riskier borrowers than myself. I applied $25 per lending note and spread the total notes by risk class (A, B, C, ratings, etc), taking into account current default rates by risk class to get an estimated return. Looking at all the notes I invested in, I know about 2.5% will default based on current data. But the fact that I diversified my investment into as many notes as possible will (hopefully) minimize my default rate.

A Closer Look at the Numbers

Taking all that into account, my return on investment is close to 15%, with a 2.5% default rate means my net return is close to 12.5%. I pay 7.78% on that capital, and pocket the difference (4.72%), or about $500 over three years.

Yes, this is a lot of work for $500, but not only does it add up quickly, its something that can be built off itself very quickly — the compounding returns only make my returns bigger over time. In my mind, I’m also helping people fulfill their needs by supplying them capital to accomplish their goals. If I can make money and their needs are satisfied, then everybody wins.

I do understand this game isn’t for everyone – I have enough cash in the bank to cover my debt if all my notes default (which has next to no chance of ever happening). But it is free money, and its a very fun 10-minute a week hobby.

More about Derek

I think its good to frame what I do with how I go about doing it. I’m a financial analyst at a growing company (a rarity these days) and because I look at capital flows professionally, over the last few years, I’ve picked up on a few tricks used by companies to grab a decent return on their capital, as well as increasing their capital on-hand for capital buildouts and revenue streams. That being said, I’ve modeled some of those strategies (albeit on a much smaller scale) in my personal life as well. Some with great results, others not so great.

One of those strategies is finding good returns on capital, and having capital offers come your way at a relatively cheap price.

Action Plan

Of course, Derek had me at hello on this one! I’m considering a small scale social lending arbitrage experiment at Lending Club for some reader enjoyment. However, it might have to wait until our credit card arbitrage strategy is exhausted. Either way, stay tuned for more details on social lending arbitrage!

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How to Get Your TradeKing Referral Bonus

1. Log into your TradeKing account, or sign up for a new TradeKing account if you don’t have one yet.
2. Enter your friends’ email addresses in their Refer a Friend dashboard and press “Send.”
3. Every time someone you refer funds their account with at least $1,000 and executes a trade, TradeKing will deposit $100 into your account.

TradeKing Terms and Conditions

• There is no limit to how many friends you can refer.
• TradeKing won’t use your friends’ emails for any purpose other than sending the referral message.
• Offer ends February 11, 2010.

More on TradeKing

Cheap Trades. $4.95 per trade (market or limit), which includes stock and ETF trades. Options have an additional 65 cents per contract. Mutual funds are $14.95 per trade.

Investment Tools. TradeKing offers all clients free access to their suite of investment research tools, like Maxit Tax Manager, Stock and Option Trading Screeners, MarketGrader Research Reports, Probability Calculator, Technical Analysis Tool, Profit and Loss Calculator, and much more.

If you don’t have a TradeKing account yet, you can sign up for a new account. For more information on TradeKing, check out our TradeKing review.

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Those defaults made me a little turned off by the idea of P2P lending, but then Lending Club offered $50 to sign up and I couldn’t resist! So about a year ago I joined Lending Club and invested in my first two loans. After a few months I was happy with the results and began transferring some of my own money to Lending Club. After several months, I’m averaging about 10.1% on roughly 30 loans – slightly above the average. Here is quick rundown of my Lending Club strategy.

My Lending Club Strategy

Each time I get paid (twice per month), I transfer $25 to Lending Club. That’s enough to fund one loan, and also a small enough amount of money that I don’t mind losing it if the borrower defaults. I also reinvest any payments I receive – I usually receive $25 in payments about every 5 weeks. When choosing my loans, I avoid using the automatic investment option (called Lending Match). Instead, I use the “Filter Notes” option to filter out notes based on these criteria:

• Amount: I found with Prosper that the single biggest predictor of default was the loan amount. Lending Club allows borrowers to request up to $25,000 – but that amount can mean a monthly payment of up to $800 depending on the interest rate. Most people simply don’t have that kind of money to throw at a loan payment – if they did, they probably wouldn’t need the loan! I filter for loans under $10,000, and usually end up selecting loans of less than $6,000 if available.
• Interest Rate: Lending Club assigns interest rates based on credit history. I look for A, B, and C borrowers, which correspond to interest rates of 7.94-13.57%. D-G borrowers have higher rates of return but also have higher default risks, so I avoid them. Even C borrowers have to be stellar everywhere else for me to consider them. I usually stick in the B range to get the best risk/reward tradeoff.
• Delinquencies: I look for borrowers with 0 delinquencies on their record. This substantially decreases the number of loans available for me to choose from, but I also believe it substantially decreases the default risk for the loan I ultimately choose.
• DTI Ratio: I look for a Debt-to-Income ratio less than 20%, so that I feel absolutely confident in the borrower’s ability to service the loan payments. Technically, borrowers should be able to afford the loan payments as long as their DTI is below 36%, but I’d rather be safe!
• Funding amount: Finally, I look for loans that are at least 50% funded. I do this for two reasons: so that I know other people thought this was a good investment and so that the loan is made and begins earning interest as quickly as possible.

Browsing Loan Detail

Once the filter has returned a group of loan listings, I take some time to browse each one individually, looking for the following:

• Type of loan: I usually look for debt consolidation loans or other personal loans – I never invest in loans for small businesses. While I would love to help business owners, I just can’t take the risk without seeing some sort of business plan. In addition, the current economy is not good for new businesses – lots of my original Prosper defaults were business loans. Medical loans also scare me, though I will invest in them periodically if the interest rate is right.
• Loan description: If there’s no description, I’m not investing. Period. If you want my money, you need to tell me why – in complete sentences with proper grammar and spelling. I think people who really are serious about the loan will take the time to do it right.
• Questions and Answers: If people have asked questions, I make sure the borrower actually answers them. Getting defensive is a bad sign – it means they’re hiding something. An answer such as “thanks for your concern, I’m trying to do better” is a non-answer. As with the description, I’m looking for proper spelling and grammar.

Choosing My Loan

Once I’ve narrowed down the originally filtered loans even further, I sort by interest rate. I then look for the highest possible interest rate for the lowest amount requested. So if there are two $3,000 loans, and one pays 9% and one pays 8%, I choose the one paying 9%. If there are two loans paying the same interest rate, I choose the one requesting the lower amount. Finally, I add it to my order and submit the order – I’ve just invested $25 more dollars!

Make It Work For You

If you’re interested in investing with Lending Club, make sure to check out this sign-up bonus. Then use “Browse Notes” and “Filter Notes” to select your lending criteria. Once the filter has returned a certain number of results, browse through the listings to check for loan descriptions, questions/answers, and anything else that interests you.

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Both sites allow borrowers to make loan requests for various purposes up to $25,000. Interested lenders can get together and fund as little as $25 per loan. The P2P site then gathers all the money, disburses it to the borrower, collects payments, and disburses them to the lenders – all for a small fee, of course!

Prosper was initially the more popular of the two websites, and grew even more when Lending Club suspended operations to register with the SEC. Then Lending Club reopened while Prosper went through a similar dark period, driving many eager investors to check out Lending Club. Both sites are reopened now, although only to investors from certain states. From buzz I’ve seen around the blogosphere, Lending Club appears to be a little more popular right now. However, Lending Club has made about $70,000,000 in total loans as compared to Prosper’s $185,000,000.  

Now that both sites are reopened (although only to people in certain states – check the terms for details!), we thought it was a good time to compare the two and try to determine which is a better deal for those of you interested in P2P. I have to give both sites credit for posting a LOT of performance data – you can view some here for Lending Club and here for Prosper.

Borrower Comparison

All loans at both sites are for a maximum of $25,000 and last for a term of 36 months.

• Where Prosper wins: Prosper offers the chance for borrowers to set an interest rate. If your rate is considered high for your deemed risk (based on credit score and history), lenders can bid down your rate, resulting in less interest paid over time. Prosper loans are available to those with a credit score of 640, compared with 660 for Lending Club . Prosper’s origination fees are fixed at 3% for most borrowers, compared to a sliding scale of 1.25 -4% for Lending Club borrowers, depending on credit history.
• Where Lending Club wins: Lending Club’s rates are fixed, but generally lower than Prosper’s rates – starting at 7.05% for borrowers with the best credit history and maxing out at 21.21% compared to 7.5% – 35% at Prosper.

Bottom Line: Borrowers with lower credit ratings will probably have a hard time getting their loans funded at either site. But if you do get your loan funded, your loan will cost less over time if you get it through Lending Club. However, if your credit score is between 640 and 660, Prosper is your only option.

Lender Comparison

Both sites allow you to invest amounts greater than $25 in individual loans and sell existing loans on a trading platform, and charge a 1% service fee on the outstanding balance of each loan.

• Interest Rates & Defaults: Prosper’s higher rates mean the chance of higher returns for you…but its higher default rates mean that those returns don’t always materialize. In the past, this was likely due to the fact that Prosper lenders often bid down loans so low that the risk-adjust rate of return was negative. Prosper has now instituted minimum interest rates to try to prevent this from happening, but hasn’t been reopened long enough to see results. In the meantime, 22.03% of Prosper’s loans have been charged off compared to a default rate of just 3% for Lending Club.
• Returns: Lending Club loans currently have an annual return of 9.67%, compared to 9.52% for Prosper. Of course returns vary widely across levels of risk, loan amounts, and loan purposes.
• Ease of investment: Lending Club has fixed rates, so what you see is what you get – as long as a loan is not fully funded, you can get in at the stated rate. Prosper allows for “bidding” of rates, meaning you may want to invest in a loan but get shoved out if your required rate is higher than the loan ultimately closes at.
• Investment amounts: Prosper lets you invest any amount over $25 – so if you receive a payment of $1.21, you can transfer over $25 and bid $26.21 on your next loan, earning interest on that payment. Lending Club only allows increments of $25, and does not pay interest on any amount remaining in your account.
• Withdrawals: Lending Club allows you to withdraw any amount that is not invested in a loan at any time. Prosper normally requires you to have a minimum of $25 before withdrawing, but lets you make a smaller withdrawal once per month. If you always reinvest your payments, this doesn’t matter, but if you want to move money around, this might be a big deal to you.
• Collections: Prosper admits to only collecting .48% of late loan payments (yes, that .48%, as in less than half of 1%!). Lending Club does not reveal its collection rate, but of course has a smaller hill to climb since default rates are so much lower! Anecdotally, I’ve never had any of my late Prosper loans successfully collected on, but I had one late Lending Club loan that entered collections and then was returned to “current” status two weeks later.

Bottom line: Lending Club appears to win on most counts. The biggest pro for Prosper is the fact that you can invest “odd” amounts rather than just $25 increments. I didn’t mention it above, but Prosper also has a slightly better interface in terms of borrower listings – borrower can include pictures and often provide more of a “story” as to why they are asking for their loans. Lending Club presents more hard numbers, and less personalization, although lenders do have room to describe their listing. Both provide a Q&A that can be viewed by all registered members.

My Experience

I have lending accounts with both Prosper and Lending Club. I joined Prosper first, and joined Lending Club during Prosper’s dark period. I haven’t gone back to Prosper because my performance at Lending Club has been far superior – I’m currently earning 9.9% on 30 notes, with only one late. At Prosper, 9 of 24 notes have been charged off - while Prosper does not show my earnings as a percentage,we can assume it’s negative at this point. I do think that Prosper is making an attempt to be stricter on lending criteria since the early days, so I have faith that it could bounce back. But in the meantime, I think I’ll stick with Lending Club.

P2P lending is an investment, and as such, it comes with some risk. At the same time, if you’re smart about borrowing, you can see excellent results.

Sign Up Bonuses

If you’re interested in P2P investing, check out these sign-up bonuses from Prosper and Lending Club. And if you are already an investor, let us know how you’re doing!

Be sure to check out tomorrow’s article, when I tell you how to achieve high returns on Lending Club!

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Prosper came first, but entered a long dark period to allow for registration with the SEC. It’s back now, and open for business to borrowers and lenders in certain states.

How Prosper Works

Borrowers apply for loans through Prosper, stating a total amount and a desired interest rate. Prosper approves the loans and lists each as an individual “note.” All loans are for a period of 36 months, with no prepayment penalty.

Borrowers can fund the note in increments of $25, and “bid” on the interest rate they are willing to pay – the lowest interest rates win. So if borrower requests a loan at 10%, investors can decide that loan is a good investment and instead be willing to loan at 8.5% just to get in on that loan. If a note is not fully funded in the requested amount, the borrower does not receive any funds. Completed loans are disbursed to the borrower, who then makes monthly payments to Prosper. Lenders can also trade existing loans through Folio Investing.

Lender Details

• Eligibility: Lender accounts are only available to residents of the following states: California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Louisiana, Maine, Minnesota, Missouri, Montana, Nevada, New Hampshire, New York, Oregon, Rhode Island, South Carolina, South Dakota, Utah, Virginia, Washington, Wisconsin and Wyoming. Lenders in the following states may be subject to suitability requirements: California, Idaho, New Hampshire, Oregon and Virginia.
• Minimum Investment: $25
• Fees: Loan servicing fee is 1% annually on the balance of each loan. Collection fees for late loans are 17% of collected amount. These fees are taken from payments before payments are disbursed to you.
• Risk: Prosper investments are not secured. If a borrower defaults on a loan, you will lose the amount invested in that loan.
• Returns: Prosper boasts annual returns that average 7-13%, depending on the credit risk of the borrowers you invest in. Higher interest rates equate with more default risk – if the borrowers come through on payments, you’ll be rewarded, but if they default you’ll lose the full investment in that loan.
• Liquidity: You receive a payment each time a borrower makes a payment to Prosper. The only way to get your outstanding investment back is to sell existing loans through the trading platform, possibly requiring you to provide a small discount.
• Diversification: You can invest in as many notes as you want, up to $5,000,000 total. Since each loan requires minimum funding of only $25, you can spread even a small amount of money through multiple lenders, thus decreasing your exposure to individual defaults.
• Interaction: You can ask questions of individual lenders and see responses to all questions.

Borrower Details

• Requirements: Resident of any US state except Iowa, Maine, or North Dakota, with a minimum FICO score of 640, with bank account and a Drivers License Number
• Loan Amounts: $1,000-$25,000
• Interest Rates: Start at 7.5% with a cap of 36%. You can request a certain interest rate and lenders will “bid” on your listing, possibly lowering your rate. Lower interest rates are usually awarded to those with a good credit history and sufficient income to make loan payments.
• Fees: 3% closing fee with a minimum of $50 for most loans. The highest rated borrowers pay a .5% closing fee. All borrowers are subject to a $15 failed payment fee and the greater of $15 or 5% of the outstanding balance for late payments.

Prosper Overall

Like other social lending sites, Prosper is a great option for borrowers looking to get financing from non-traditional sources. Lenders can often earn higher rates than savings accounts and spread their investment risk by investing in multiple notes. The trading platform means that you can get at least some of your money back if you have a quick need for cash. I made about 15 loans through Prosper before it entered its dark period, but haven’t made any since.

Prosper Sign Up Bonus

If you’re interested in checking it out, don’t forget about the $50 sign up bonus going on now!

Stop back tomorrow for a comparison of Prosper and Lending Club!

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